Take the money or open the box?

Delaying decision-making to a later date is something that most company directors have probably spent much of their working lives battling against but, nevertheless, as the end of their own careers approach, it may be in many senior executives’ best interests to embrace this alien strategy, at least insofar as their pension arrangements are concerned.

Company directors and senior employees who are due to take benefits, or who opt to defer drawing any planned pension benefits until, after April 2006 could reap a financial reward as a result of the Governments pensions simplification legislation.

Whilst much recent comment has centred on the potentially negative impact of these proposals on a limited number of individuals fortunate enough to have a pension fund in excess of £1.5 million, what is often overlooked is that the simplification proposals will present many senior executives with fund values below that level with far greater flexibility in the structure of their pension arrangements than has hitherto been available to them.

For example, at present, someone retiring with a maximum pension fund of £1.5 million in an occupational pension scheme would, in most cases, be able to take a maximum lump sum cash amount of only £153,000 equating to around 10 per cent of the fund value. Come A-Day they could be entitled to receive £375,000 – or 25 per cent – from the same fund. Obviously this leaves less of the fund to be taken as pension and may result in a lower retirement income, but for those individuals seeking to maximise their tax free cash sum on retirement this could be an attractive option and potentially even worth deferring retirement for.

However, it is not only individuals with benefits in the millions who could benefit but potentially any individual whose tax free cash sum under their current regime would be below 25% of their fund value.

The maximum amount of cash an individual can take out of his or her fund in an occupational pension scheme is primarily based upon their salary and service. In most circumstances the maximum salary which can be used will be the earnings cap, currently £102,000 and based upon maximum service the maximum tax free cash sum would be £153,000. This would mean that anyone with a fund value in excess of £612,000 would receive less than 25 per cent of their overall fund as a cash sum. This means that, post A-Day, when tax free cash will be simplified to a straight 25 per cent of the fund, anyone with a pension fund valued above this level but below £1.5 million will have the opportunity to increase the amount of tax free cash they can take on retirement. In addition anyone with less than maximum service with their company or salaries below the earnings cap could also see an increase in the available tax free cash under the new rules.

Furthermore, under occupational money purchase pension schemes, individuals are presently forced to buy escalating pensions which means that, ultimately, they will receive less from their pension funds initially than if they were able to buy a level pension. Post-A-Day, however, they would have the option to buy a level pension which might be considerably more attractive to them, particularly where they consider their life expectancy to be below average.

Not only are senior executives in money purchase arrangements likely to have considerably greater choice in terms of the level of potential escalation on pension post A-day, but they will be able to choose preferred levels of widows benefits, levels of guarantee and the proportion of the overall benefit that they wish to access as, for the first time, they will be able to take portions of the benefit instead of being obliged to take the whole amount at one time. Such enhanced flexibility is likely to prove attractive to many, including members of final salary schemes who may wish to transfer benefits to money purchase arrangements on retirement to avail of the improved flexibility.

So too will the fact that, while contributions to occupational schemes are also presently calculated based upon an individual’s salary, after A-Day the employer contribution can be anything up to £215,000 a year, regardless of an individual’s level of salary or length of service. This provides company directors with considerable additional scope in terms of how they choose to structure their income, such as the relative mix of dividends and salary, whereby retiring company directors might opt for higher dividends and a lower salary which would require them to pay lower national insurance contributions.

It is because of such flexibility that anyone presently considering retirement, particularly senior executives with higher fund values, should be considering the merit of making additional contributions as well checking whether or not it might be worthwhile deferring taking their benefits until after A-Day. It is therefore well worth seeking financial advice prior to taking any pre A-Day decisions as the new regime needs to be factored into retirement planning now and it is essential that individuals understand the wide range of options that will be available to them.

While a few poor souls with more than £1.5 million in their pension pots will see their benefits curtailed post A-Day, the vast majority with benefits less than this figure could well find themselves substantially better off.